Suit Claims Bank Knew Investments Were Bad

By REUTERS

Published: December 30, 2009

The investment giant Morgan Stanley has been sued by a Virgin Islands pension fund that accused the bank of defrauding investors by marketing $1.2 billion of risky mortgage-related notes that it expected to fail.

The lawsuit filed Dec. 24 in a Manhattan federal court accused Morgan Stanley of collaborating with the credit rating agencies Moody's Investors Service and Standard & Poor's to obtain triple-A ratings for notes sold in 2007 as part of a collateralized debt obligation, or C.D.O., known as Libertas.

According to the complaint, the C.D.O. was backed by low-quality assets, including securities issued by the subprime lenders New Century Financial Corporation which quickly went bankrupt, and Option One Mortgage, then owned by H&R Block.

The complaint asserted that Morgan Stanley knew the C.D.O.'s assets were far riskier than the ratings suggested, but was ''highly motivated to defraud investors'' with pristine ratings because it was simultaneously ''shorting'' almost all the assets. Shorting is a bet that their value would fall, which it did in 2008.

''Morgan Stanley was betting the entire investment it was promoting would fail,'' according to the complaint, which was made available on Tuesday. ''The firm achieved its objective.''

Alyson Barnes, a Morgan Stanley spokeswoman, declined to comment. An S.& P. spokesman, Frank Briamonte, had no immediate comment. Moody's did not immediately return a call. Moody's, a unit of the Moody's Corporation, and S.& P., a unit of McGraw-Hill Companies, were not named as defendants.

Many banks face lawsuits from investors who say they were misled into investing in securities they believed were safe but which were in fact tied to risky subprime mortgages.

Morgan Stanley is also a defendant in a closely watched case in the same Manhattan court that concerns whether rating agencies deserve free speech protection for their opinions.